Further tightening in the UK

Bank of England Governor, Mervyn King, has warned households to prepare for further increases in interest rates as inflation creeps higher. Mervyn King’s comments came after the Bank published its February Inflation Report, in which it lowered its forecast for economic growth this year from 2.6% to around 2% and confirmed that inflation could reach 5% before June – the UK has a target rate of 2% for the Consumer Price Index.

Currently the UK Bank Rate (equivalent to OCR in NZ) is at 0.5% but is expected to rise to 0.75% in the next four months and be at 1% by the end of the year. Projections for 2012 is 2% and by the end of 2013 the rate will be at 3%. Mervyn King also acknowledged that an 0.25% increase in the Bank Rate would not damage growth. “There’s one camp that says even a small rise in Bank rate, no matter how small, will plunge us back into recession and mean that hopes of recovery are dashed forever. I don’t really understand the logic behind that,” he said.

Compared to Australia and New Zealand rates in the UK, and US for that matter, are still very stimulatory – see table above. Interesting to note that the economies with higher interest rates are those that are more commodity based. It would be a useful exercise to draw a business cycle graph and look at the relationship between each country’s key interest rate and where they are on the business cycle.

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